China called for the creation of a new currency to eventually replace the dollar as the world’s standard, proposing a sweeping overhaul of global finance that reflects developing nations’ growing unhappiness with the U.S. role in the world economy.

The unusual proposal, made by central bank governor Zhou Xiaochuan in an essay released Monday in Beijing, is part of China’s increasingly assertive approach to shaping the global response to the financial crisis.

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Mr. Zhou isn’t the first to make that argument. “The dollar reserve system is part of the problem,” Joseph Stiglitz, the Columbia University economist, said in a speech in Shanghai last week, because it meant so much of the world’s cash was funneled into the U.S. “We need a global reserve system,” he said in the speech.

Dr. Krugman says China is stuck with dollars and now is looking for easy way out.

The big news last week was a speech by Zhou Xiaochuan, the governor of China’s central bank, calling for a new “super-sovereign reserve currency.”

The paranoid wing of the Republican Party promptly warned of a dastardly plot to make America give up the dollar. But Mr. Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.

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Two years ago, we lived in a world in which China could save much more than it invested and dispose of the excess savings in America. That world is gone.

Yet the day after his new-reserve-currency speech, Mr. Zhou gave another speech in which he seemed to assert that China’s extremely high savings rate is immutable, a result of Confucianism, which values “anti-extravagance.” Meanwhile, “it is not the right time” for the United States to save more. In other words, let’s go on as we were.

That’s also not going to happen.

The bottom line is that China hasn’t yet faced up to the wrenching changes that will be needed to deal with this global crisis. The same could, of course, be said of the Japanese, the Europeans — and us.
And that failure to face up to new realities is the main reason that, despite some glimmers of good news — the G-20 summit accomplished more than I thought it would — this crisis probably still has years to run.

China’s 2007-2008 bet on global equities and riskier bonds likely cost it north of $50 billion — it all depends on exactly how much of its portfolio it put into risk assets. To be sure, it is in far better shape than Ontario Teacher’s Pension Plan, which lost a staggering 40% on its fixed income portfolio. Most of China’s reserves were in safe government bonds, and those bonds increased in value over the course of the crisis. But as Arvind Subramanian notes, China’s currency losses will eventually dwarf its equity market losses.

Those losses shouldn’t be a surprise. Currency losses on unneeded reserves are the price a country pays for subsidizing its exports with an undervalued exchange rate. But that doesn’t make it any easier to accept the losses – or to handle the inevitable argument that China’s leaders squandered China’s reserves.

China’s leaders are setting the stage to argue that these losses are the fault of bad US policies. They aren’t. They are the result of China’s own policy choices. Subramanian correctly observes “[China] is seeing itself as the victim of the dollar standard when it has been, for a long time, a beneficiary and promoter of this standard.” China’s leaders, though, have no incentive to recognize this.

But even if China didn’t explicitly plan to build up to many reserves, it now has them — and China’s leaders are no doubt interested in using them to increase China’s influence.

It isn’t hard to think of creative ways China could use its reserves to increase its global position. China alone could provide all the extra $500 billion the IMF now needs if it wanted to do so. Or it could set up a Chinese monetary fund to compete with the IMF.

To date, China has been fairly cautious, generally turning down countries that trekked to Beijing to appeal for emergency loans – though the recent expansion of RMB swap lines suggests that China may now be willing to take more risks. One potential problem: China would need to explain to its own citizens why it is using its reserves to help other countries rather than doing more at home.*

And then there is the elephant in the room: Will China’s large dollar holdings — and the fact that is is now the United States largest creditor — give it any influence over US policy?

No matter how this whole situation turns out, what China is going to do with its massive dollar reserves will decide the future of the US, the world financial system and US-China relationship. A lot depends on how China behave from here on.

Shining metals are shining like never before – however old let it be, it is still Gold.

The recent rally in Gold is two thumbs down by owner’s of the wealth to the ponzi scheme fraudsters called central bankers, who print pieces of paper called currency notes and tell you to pretend that it is substitute for your wealth.

For there will be blood and chaos – perhaps all of 2009, perhaps more. And when this ends, a new world order will emerge. But first, we need to weather this storm.

People thought that history will treat George Bush as someone who brought US to her new lows. Now it appears that history will remember Mr. Bush as someone who drilled such big a hole in the titanic of US that it was just a matter of time before it eventually sank.

FRONTLINE released its documentary ‘Inside the Meltdown’ on PBS.org capturing the dramatic wall street events of 2008.

The documentary runs for 1 hour capturing the events starting from Bear Sterns collapse. Devoid of any charts and figures, the focus of documentary is to present timeline, events and anecdotes rather than presenting an analysis of the crisis. It does meet its goal.

One of the main culprit of subprime mortgage collapse was principal-agent problem.

For bankers, incentive to cheat and make a quick buck in bonuses was much larger than incentive to earn steady and secure profits for shareholders. There hasn’t been enough discussion surrounding this important area.

Free Markets can work, only if free markets can devise an effective remedy to principal-agent problem. If not, effective regulation is the only alternative.

Bad bank? Hmmm .. bad bank! How good can it be, when they name it bad bank?

What is Bad bank?

‘Bad Bank’ is the new gimmick tossed around by the same people who came up with but could not work out TARP – Troubled Assets Relief Program. The same set of intellientia has rebranded TARP as ‘Bad Bank’ and is running around proselytizing people to their newly formed faith – born again TARP.
“Bad Bank’ aims at isolating toxic trash from banks’ assets and create a new giant bad bank to carry only this toxic junk. This will improve the quality of asset book of all the banks and they will be back in their usual business of lending again. Good thought. So where is the problem?
The problem is, who will provide the capital for ‘Bad Bank’? Since most of the assets that are going to end up on the balance sheet of Bad Bank are worth nothing, they are essentially going to eat up most of the capital. So in the name of which crazy f*ing variant of capitalism, is it fair to ask taxpayers to cough up the capital for ‘Bad Bank’? They call it Lemon Socialism. I am no fan of socialism, but pure socialism is million times better than this Lemon Socialism.
The idea of ‘Bad Bank’ is going to fail for exact same reason the original idea of TARP failed. How to price the Toxic Assets? If they are priced at what they are worth i.e. zero, no bank will be willing to part them from their balance sheets. If they are priced anywhere near their book value, it is really bad deal for taxpayers.

Let’s look at what are the general perspectives we get to hear about Bad Bank.

The smart ones …

These people are the founding fathers of Bad Bank initiatives – the shrewd class of diplomats in cahoots with nation’s bankers. They have their own interests in getting things running again – even if it comes at the cost of taxpayer dollars. They want to sell this idea of Bad Bank somehow, because it is one perfect medicine that will mop up all the dirt from balance sheets of all banks. the ultimate cleansing of body and soul, you see.

The naive ones …

There are always few who fall for such cunning ideas of political craft. They say that toxic assets are in reality worth more than what they sell for in the market. So if gov’t sits over these assets for long duration, taxpayers will end up making profit on in. Okay. So markets don’t know how to price these assets, eh? But wait a minute, markets are supposed to know the best, isn’t it? Yes, and they do. These assets are really worth nothing.

The wise ones …

This includes economists like Joe Stglitz , Paul Krugman and Yves Smith, who openly criticized the idea of Bad Bank in its current form – just because it is exactly what it says it is .. Bad.

One of the main reasons why this recessions is going to be deep and prolonged is savings rate in US had hit rock bottom and with people losing money all around, you can not expect them to keep spending at the same rate. (besides even if that happens, it will be even more disastrous) That’s why gov’t spending is so very crucial at this point.

Leading economist and FT columnist Martin Wolf has written a superb article in today’s FT calling for pragmatic approach as a way forward.

Sir, you spoke for all of us who wished that people push aside their puritan ideologies and without going into left and right of it take pragmatic steps solving the crisis.

The article takes its inspiration from the the great John Maynard Keynes, but the theme of article is that we need Keynes’ much more than Keynes policies ditto. If there is one thing that separated Keynes from his contemporaries, according to the article, it is the fact that he took much more pragmatic approach to solving issues as against being ideologically correct.

According to the author, the three main lessons to take from JMK were (emphasis mine),

I see three broad lessons.

The first, which was taken forward by Minsky, is that we should not take the pretensions of financiers seriously. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” Not for him, then, was the notion of “efficient markets”.

The second lesson is that the economy cannot be analysed in the same way as an individual business. For an individual company, it makes sense to cut costs. If the world tries to do so, it will merely shrink demand. An individual may not spend all his income. But the world must do so.

The third and most important lesson is that one should not treat the economy as a morality tale. In the 1930s, two opposing ideological visions were on offer: the Austrian; and the socialist. The Austrians – Ludwig von Mises and Friedrich von Hayek – argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behaviour guaranteed a stable economic order; the latter in the idea that the identical motivation could lead only to exploitation, instability and crisis.

We need not dump the idea of free market economy saying that markets don’t work, nor we should fool ourselves in believing that markets will find their way out of this crisis on their own. This is an unusual event that calls for radical measures which may not be ideal, but may work. Results are more important than the means right now.

The article goes on to outline the present priorities in front of us (emphasis mine),

The urgent task is to return the world economy to health.

The shorter-term challenge is to sustain aggregate demand, as Keynes would have recommended. Also important will be direct central-bank finance of borrowers. It is evident that much of the load will fall on the US, largely because the Europeans, Japanese and even the Chinese are too inert, too complacent, or too weak. Given the correction of household spending under way in the deficit countries, this period of high government spending is, alas, likely to last for years. At the same time, a big effort must be made to purge the balance sheets of households and the financial system. A debt-for-equity swap is surely going to be necessary.

The longer-term challenge is to force a rebalancing of global demand. Deficit countries cannot be expected to spend their way into bankruptcy, while surplus countries condemn as profligacy the spending from which their exporters benefit so much. In the necessary attempt to reconstruct the global economic order, on which the new administration must focus, this will be a central issue. It is one Keynes himself had in mind when he put forward his ideas for the postwar monetary system at the Bretton Woods conference in 1944.

I think Europeans are too complacent at this point. With deflation and demand destruction staring in the face, ECB’s procrastination to cut rates is baffling. Also the concerted effort for fiscal stimulus, which is required to get spending back on track, seems unlikely thanks to adamant Germany. On the other hand, Chinese still wants to rely on US exports to bail their economy out as against stimulating their domestic consumption. China will do a lot good by letting RMB appreciate a bit. But alas, they want to stack up more and more US dollars and throw good RMBs at bad RMBs.

The article concludes the message as (emphasis mine),

As was the case in the 1930s, we also have a choice: it is to deal with these challenges co-operatively and pragmatically or let ideological blinkers and selfishness obstruct us. The objective is also clear: to preserve an open and at least reasonably stable world economy that offers opportunity to as much of humanity as possible. We have done a disturbingly poor job of this in recent years. We must do better. We can do so, provided we approach the task in a spirit of humility and pragmatism, shorn of ideological blinkers.

As Oscar Wilde might have said, in economics, the truth is rarely pure and never simple. That is, for me, the biggest lesson of this crisis. It is also the one Keynes himself still teaches.

In Nov’2005 – yes, way back in two thousand and five – Madoff’s rival hedge fund manager Markopolos submitted this written complaint to SEC.

The title of the submission reads “The world’s largest Hedge Fund is fraud”
In opening remarks he gives two likely scenarios and says scenario-2 is highly likely.
According to Markopoloas, What was this scenario-2?

Then the paper goes on to describe its premise in very compelling and coherent manner over next nineteen pages.

So what did SEC do?
SEC closed the case in Nov’07, two years later, and SEC’s conclusion can be found here.

Conclusion Reached:
The staff found no evidence of fraud. …..

Inefficient and insufficient gov’t oversight is one of the main reasons why market economy stands where it stands today – on the brink.

Thank you SEC, we’d love to have socialism back. We’d rather gov’t screwed us directly than gov’t colluded with corrupt market practices to screw us. Because in that case at least we have a visible filthy fist to fight with.

Okay, so finally Fed fired the last ammo left in its weaponry and dropped the target funds rate to zero. That’s as far as they can go. On top of it, Fed also announced that they are going to buy all kinds of shit that no one else wants on their balance sheets. In short, Fed has dropped its pants – the last piece of clothing it’d had- and came out all open in desperate effort to save financial system from imminent implosion. Possibly, the only thing on Fed’s mind while making this historic decision was the lost decade in Japan in deflation and liquidity trap. Japan was too late to respond and drop the rates to ground-zero and more importantly japan failed to effectively manage interest rate expectations. Fed has certainly done the first thing and Fed probably wants to do the second by buying longer term treasuries to keep long term rates low as well.

Well, so far so good. But no matter what Fed does as a part of monetary policy, unless it is supported by equivalent fiscal stimulus, seems like it may not prove effective enough. Because the only effect of $ printing press by Fed so far has been demand explosion for treasuries, which kinda defeats the whole purpose.

Market is definitely happy about Fed’s move and cheered the news with 350 points bump. But will the party last?

About

08 November 2008
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It’s 08Nov08 today. The financial crisis, which started with housing meltdown in US, has unfolded itself massively on global scale. This diary is an attempt to present the events as and when they happen from now onwards. I will try to keep it as factual as possible and looking to update it at least once in a week.
I am not an economist, so hoping to get layman’s common sense perspective on events of the crisis.
Crisis Diary as it unfolds …